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Fed’s William Emmons on Real Estate and Economy

Federal regulators and economist have been warning the industry, the public, and the administration for a good many months now about the devastation a commercial real estate (CRE) meltdown could leave in its wake.


On Tuesday, a gentleman personifying both factions of these red-flag-raisers â€" William Emmons, economist and assistant vice president at the Federal Reserve Bank of St. Louis â€" spoke to attendees at ""The Five Star Institute's"":http://www.fivestarinstitute.com ""Commercial Default 360"":http://www.commercialdefault360.com event in Dallas.

Emmons cited three primary risks to the nation's economy and fragile recovery: unemployment; the probability that recent high rates of productivity won't continue; and that ever-pressing matter of commercial real estate. Emmons says it's the first time since the 1990s that CRE has played this central of a role in the overall functioning of the national economy.

Until now, Emmons said, ""Most of us â€" inside the Fed and outside the Fed â€" really didn't see quite how dangerous the situation with the credit bubble really was.""

We've now hit a stage of involuntary deleveraging, Emmons explains.

""The long-term leverage trend in the U.S. can be summed up in one word: Up,"" he said. But now, ""we're moving in reverse and it will be some number of years â€" and I do mean years â€" before we get back to sustainable debt-to-income, debt-to-asset levels.""


Emmons says economic recovery is likely to be hampered if deleveraging continues much longer or accelerates. Either way, he contends that in the commercial real estate sector, and residential as well, there's still a lot more loss to come.

Though the residential downturn, by most indicators, seems to be lessening in its severity, Emmons did touch on some single-family housing trends and called one graphical depiction of home equity ""absolutely the scariest picture"" of his presentation.

Breaking down the economics of the plunging line on the chart, he explained that the total value of U.S. household real estate peaked in 2006 at $10 trillion, as estimated by the Federal Reserve. At that time, the Fed economists subtracted two-thirds of that amount as total homeowner ""mortgage debt."" The remaining one-third left over equates to housing equity.

By 2009, Emmons went on to explain, the overall mortgage debt figure had grown so significantly compared to estimated residential real estate value that the equity line dropped to very near zero â€" another testament to the underwater issue that now plagues so many homeowners and is already making its way into the CRE sector.

""We're still bleeding in the household sector,"" Emmons said. ""This is not a political statement, but I don't believe our loan modification programs have been effective.""

Commercial real estate property values have fallen sharply; not as sharply as the picture Emmons painted above of housing equity, but still considerably high loan-to-value ratios, he said. Add to that the breaking down of the commercial mortgage-backed securities (CMBS) market in the fourth quarter of 2007 and the continued economic strains, and it's expected to be a tough road ahead still for CRE.

Emmons explained that commercial real estate is what's called a derivative asset â€" it derives its value from overall economic growth. And, ""this is not your father's economic recovery. It's going to be a struggle and the financial pressures are likely to be with us for some time,"" Emmons said, but he adds that the ""Fed is optimistic we are past the worst"" of this economic cycle.

About Author: Carrie Bay

Carrie Bay is a freelance writer for DS News and its sister publication MReport. She served as online editor for DSNews.com from 2008 through 2011. Prior to joining DS News and the Five Star organization, she managed public relations, marketing, and media relations initiatives for several B2B companies in the financial services, technology, and telecommunications industries. She also wrote for retail and nonprofit organizations upon graduating from Texas A&M University with degrees in journalism and English.

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